Thursday, June 12, 2008 11 comments ++[ CLICK TO COMMENT ]++

Edward Lampert Going Totally Contrarian

There is a small running debate on this blog between I and Synchro, who is a superbear who woke up from his hibernation from, I assume, the hinterlands of America ;) One of his/her thoughts is that some investors, such as Bill Miller and Martin Whitman, who are making huge contrarian bets in the current environment are going to be proven wrong. His/her view seems to be that these investors were lucky, rather than skilled, during the unusually long bull market in the 80's and 90's. Well, add Edward Lampert, who runs the successful ESL hedge fund, to that list.

I knew Edward Lampert looks into unpopular areas (eg. K-mart, Sears, etc) but I never quite considered him to be a contrarian. Well, I am surprised to hear that he is making extremely contrarian bets on a housing turnaround.

(source: Lampert Puts Money On Housing Rebound, By GARY MCWILLIAMS. June 12, 2008; Page C4. The Wall Street Journal)

Billionaire hedge-fund manager Edward S. Lampert is placing new bets on a U.S. housing recovery, buying stakes in beaten-up home builders, mortgage lenders and a home-improvement retailer...


ESL acquired small stakes in U.S. home builders Centex Corp. and KB Home, according to its latest Securities and Exchange Commission filings. At recent prices, the stakes in the two home builders are valued at $10.4 million and $10.8 million, respectively.

ESL also is tip-toeing into mortgage origination and servicing, acquiring about four million shares of CIT Group Inc., a struggling subprime home and commercial lender, as well as 1.4 million shares of PHH Corp., a mortgage originator and mortgage-service company.


Going into mortgage lenders, homebuilders, and home suppliers means that you are venturing into industries extremely disliked by the market. In my opinion, these areas are near the extreme end of the contrarian scale (the only ones even further on the scale are areas such as financials (like the monolines :) ), newspaper publishers, forestry stocks, and a few others.)

Except for the Home Depot and Sears ownership--both of which have huge leverage to housing--these newly disclosed positions are very small so he isn't staking his future on a housing turnaround like Bill Miller is. Nevertheless I never expected him to be so focused on these housing-related stocks.

Some of these seem like 'test positions' since the stakes are so small. Like other superinvestors (except possibly Warren Buffett), he does make quite a few mistakes (eg. Citigroup last year). I'm curious to see how this all plays out.

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11 Response to Edward Lampert Going Totally Contrarian

contrariandutch
June 12, 2008 at 2:33 PM

Well, Lampert did always have a contrarian streak. The K-mart and Sears investements for example have a contrarian flavour as both are severely beaten up companies thouroughly disliked by most investors. Lampert went straight against that bigtime.

Meanwhile, what's with the weirdness in MBIA % Ambac price action? Prices jump 10-20% then erode on no news that I can find?

June 12, 2008 at 2:51 PM

Hi ContrarianDutch...

I think the Ambac investment is having a detrimental impact on me ;) It's making me leave long-winded rebuttals to posters at various blogs I visit :) Left a long message at nakedcapitalism.com after I disagreed with the author's view of MBIA holding onto its money.

The monoline shares are very volatile and the 10% daily moves are nothing new. Momentum investors are all over these stocks so who knows what is driving these stocks?

Today's run-up seems to be due to a big block trade... 500k+ trades around 11AM. The stock has been selling off since those big volume trades. I'm sure you know this but the stock rising on a big block is good news since it means the buying is stronger than the selling (i.e. instead of panic selling, this is more of a buy.) It could be short-covering but it's hard to say.

The real question mark to me is what happened yesterday. Ambac somehow had fairly sustained buying at around $1.95 and finished marginally positive while the market was selling off everything (except oil & gold of course).

Does this mean there are some interested big buyers out there?




As for Edward Lampert, do you know what he invested in in the late 90's and early 2000's? I can't really find much about him before his K-mart purchase. I never considered him as a contrarian but if he raises his housing-related stakes, my opinion will have to change...

June 12, 2008 at 2:56 PM

ContrarianDutch, you may have already seen it but if not, check out MBIA's letter to shareholders as well. Nothing earth-shattering but it's good to get the view of the executive...

http://investor.mbia.com/phoenix.zhtml?c=88095&p=irol-newsArticle&ID=1165024&highlight=

contrariandutch
June 12, 2008 at 7:57 PM

Hello Sivaram,

Don't let the bears gleefullness get to you. We will see in about two years or so who has the final laugh, no?

The big move up on heavy volume is good news indeed as it suggests serious money has startes buying. Doesn't look like a short squeeze though, that usually happens after a sustained runup pushes the shorts through their margin requirements (another rally like this and a short squeeze might be on the menu). Yesterdat it appears somebody had a really big limit order out for Ambac and selling got absorbed into it. Good news too, as somebody(s) with money appear to be committng. The fact that Ambac dropped comparatively modestly on insane volume of 60 million shares when it got kicked out of the S&P 500 among other things also suggests there is some buying power getting deployed.

I had read the letter by MBIA chief Brown and it doesn't seem to say much that is new. The one thing I really did like is his view that no more loss reserves will be needed. The real (as opposed to reversible mark-to-mrket) bleeding may be ending. I also conforms the impression I got at, among places, bankstocks.com that the mortgage front is improving (albeit only from "horrendous" to "really bad").

I can't seem to find much on Lampert. My Google-fu is weak today. What I found is that he got his first big succes buying banks around '91 in the wake of the S&L blowup. He has been specializing in struggling retailers (K-mart, Sears, Autozone, Autonation). since. Runs a very concentrated value-orientes portfolio with what I think is a definite contrarian streak (but I think contrarian and value investing are complementary anyway as beaten up out of favor stocks are most likely to offer value at discount prices).

synchro
June 13, 2008 at 1:27 AM

Buying a stock just because it is down big doesn't automatically mean it is value or contrarian investing. When you average down on a stock, you better be you are not ignoring reality and driven by an ego to be right. In my mind, it is professional malpractice for a portfolio manager handling other people's money to persist with a position that has lost more than 70%, 80% or 90% of its value -- the market is telling the manager HE IS WRONG. And when there is a _pattern_ with this average-down behavior (MBIA, Ambac, Bear Stearns, the homebuilders, Eastman Kodak, WAMU, AIG, the mortgage guarantors), that tells me the portfolio manager has lost his way (and his mind).

Warren Buffet has said he likes to buy companies that has such a strong franchise that even an idiot can run it. That's how he defines VALUE (business with a strong moat). So here is a thought experiment for aspiring self-described contrarian investors: which of the businesses that Miller, Whitman and Lampert have bought lately can be successfully run by an idiot? MBIA? Ambac? K-mart? the Homebuilders? WAMU?

It sounds to me that these crappy businesses would require an heroic effort by a genius to turn them around.

So, would Warren Buffet consider buying these businesses at the current stage of the economic cycle?

contrariandutch
June 13, 2008 at 5:38 AM

Synchro,

Just because a stock has gone down a lot does indeed not make it a "value" or "contrarian" stock. There is a second requirement, and that is that there must be value in the stock that the market will not recognize.

Buffet has for many years invested primarily in stable growing businesses that for some reason become available at a relatively low price. This appears mainly to be a function of the sheer size of the capital under his management. Buffet has no maneuvrability as any significant move by him will move the market in most stocks. And every year billions of $ are added So Buffet now invests with a horizon of "forever". The " early Buffet" operated differently and often bought heavily in badly beaten up stocks that were likely to recover.

Buffet's statement that he likes businesses that can be run by an idiot completely contradicts the great importnce he attaches to good management (an essential requirement for Buffet to buy into a business is that he has confidence in the management). Also, I think any business can be ruined by idiotic management. Buffet was probably speaking of an " ideal" business that he would like to buy but has never found.

As to recent investments by Lampert, Whitman and Miller, they have all been very busy catching falling knives and are sitting on substantial unrealized losses. However, they all bought these companies (Kmart, Sears, monolines, homebuilders, WaMu) because they expect a major improvement in the situation in two or more years. The fact that they haven't been proven right yet doesn's mean they will not be proven right in due time.

It is quite possible that Miller, Lampert and Whitman (and me) are all wrong but I think it is to early to tell if this is so.

As to Buffett, everybody declared him crazy when he bought heavily into consumer goods companies in the seventies/early eighties. "The market" felt that oil companies were the only thing of value. Then the oil price collapsed, consumer good companies saw strong improvement in earnings on the back of an improving US economy and Buffett went on to become very seriously rich instead of merely rich. In the late nineties Buffet (and also Whitman, Miller & Lampert) ignored the internetboom and was declared crazy again. The internetboom popped and Buffet marched steadily on to become not just really rich but a prophet of investing to many.

As to the market telling an investor that he is wrong, the whole point of all contrarian and value strategies is to second guess the market. The idea is that the market will turn round eventually. It is entirely possible that your position shows a loss in the meantime (Buffet is now sitting on large losses on positions in Citigroup and USG, he still seems to think the companies will be okay in a few years and is holding).

I would sell the monolines if I became convinced I have made a mistake and think the monolines are worth much less then I originally estimated. The stock price is immaterial to that and I haven't seen an analysis that actually shows the monolines to be worth much less then their current GAAP book value. Even William Ackman did not arrive at estimated losses substantially greater then the losses now implied by the marks to market.

Last but not least, the monolines would be okay in runoff I think. If they were run by idiots and the idiots just sit still, yes these companies could actually be run by idiots and shareholders would be okay (Kmart, Sears, WaMu and the homebuilders are a different matter.

The market is strongly driven by emotion and for the moment financial stocks are driven by fear. If you had bought big time into commodity related stocks in the mid nineties when commodities were at very low prices you would have been considered an idiot back then and a genius now. I still think financials will have a similar trajectory.

(Sivaram, The madness is spreading, here I am writing long posts to explain myself to people I don't even know and are thousands of miles away!)

June 13, 2008 at 10:36 AM

ContrarianDutch,

I have a good sense of humour so I don't take things too seriously (also, although it's most of my, albeit small, life savings, the money I have invested isn't needed for anything. I'm learning to fish and if the boat sinks, oh well.)

I think answering bears is a good exercise. There is nothing worse than blindly believing that one is right. It also makes me do research or think about particular issues more deeply. For instance, the fact that there is a huge controversy in some circles over MBIA not downstreaming money it raised (from its own investors I might add), makes me think about the corporate structure and what the monolines may need to do if they recover somewhat later in the year. For example, I have no idea what MBIA is planning to do but would buying back debt make sense? Given that the debt is the primary thing that can bankrupt the holding company, does it make sense to buy it back at depressed market prices? Or would buying back stock make sense (since that has the highest cost of capital)? Or should it just do nothing and earn the 3% (or whatever) interest? At some point, assuming Ambac recovers, it will get a dividend from the subsidiary and it's interesting to think about what it should be doing.

June 13, 2008 at 11:05 AM

Syncro,

I agree with you that just because something dropped 50% doesnt' mean it's cheap. You need to look no further than mortgage lenders (many of whom went bankrupt) or the infamous dot-coms from a few years ago.


Not everyone follows everything Buffett says or does. Although he is the best investor to emulate and learn from, his strategies are just one of a bunch out there. For instance, some of Buffett's strategies completely conflict with Benjamin Graham (an example is Buffett's reluctance to diversify whereas Graham was a proponent of diversification). Are you saying that Graham is wrong?

When you refer to Buffett's view of buying businesses that any fool can run, well, that's just one strategy. In fact, as ContrarianDutch pointed out, Buffett himself puts HUGE emphasis on management, so he doesn't necessarily buy businesses that anyone can run (otherwise why care about management?) In fact, nearly all of Buffett's private purchases (you know, those family businesses owned by Berkshire) will run into problems if management dissapeared.

Furthermore--and this is why I don't follow him too closely--as Martin Whitman has said many times, Buffett is a control investor. Buffett typically takes a huge stake (often 5%+ of a company, making Berkshire the #1 shareholder), sometimes sits on board of directors or at least talks with them a lot, and even influences management at times. He doesn't totally control management like Edward Lampert but he does deal with management a lot.

Lastly, your notion of market prices being the ultimate arbiter of truth may be true most of the time, but not at all times. The only people who believe that are either (i) traders (i.e. short-term time horizon and treat prices as a number wtihout any knowledge of the undelrying business), or (ii) EMH believers. Avoiding something that dropped 70% goes against contrarian investing and some value investing strategies. Many contrarians and value investors keep averaging into losing positions. You perceive that as a poor strategy, many do it.

My impression is that Buffett doesn't average down into declining stocks these days (mostly because he invests in comapnies that rarely go down), but he did so in his earlier days--the days which shows off his spectacular skills.

If I'm not mistaken, Warren's Buffett purchase of American Express dropped after he bought it. It's not entirely clear but I believe he started buying in the middle of the Salad Oil scandal and the price kept dropping (some even thought the company was going to go bankrupt).

I think his purchase of GEICO stock, and preferred shares I believe(?), dropped too. I'm not too clear on this part because maybe someone reading this can confirm or refute that (was Buffett buying while Geico was dropping?).


The thing with Buffett is that you have to take what he says WITHIN CONTEXT. He says a lot of stuff so it's easy to see how people refer to a million things from him that are sometimes contradictory. For example consider derivatives.

Some blindly take Buffett's view that derivatives are financial weapons of destruction to mean that all derivatives are bad and one should stay away from them. Well, Buffett himself has invested heavily in derivatives lately ("short" put options on some exchanges if I recall). What Buffett actually meant was that derivatives in the wrong hands, or combined with excessive risk taking, is dangerous. Anyone taking that out of context would be contradicting what Buffett...

contrariandutch
June 13, 2008 at 5:02 PM

Whitman just published his q2 commentary. It appears he has significantly expanded his ABK holdings.

synchro
June 13, 2008 at 6:04 PM

When a stock drops 70% ~ 90%, the market's verdict seems pretty definitive. I can understand one "second-guessing" a 20% or 30% drop. There's a pt beyond which it may make sense for one to get serious about whether his own analyisis is objective/rationale or delsuion/wishful thinking.

For a stock to drop 90%, it needs rise 10x to break even. What are the odds?

Regarding buying companies with good management, I wonder if MBIA/ABK qualify as having "good management?"

June 13, 2008 at 8:20 PM

Synchro, I have the perfect post to answer your questions. If you don't mind, I'll quote your post and answer your first couple of paragraphs with the classic case of American Express in the early 70's.


As for the comment about management, I will completely agree with you if you are saying that management doesn't know what they were doing. I totally concur. I mean, these companies wouldn't be taking billions in losses otherwise. However, my response was not to defend the management of these monolines (or any of the banks or any of the reatilers or anything else that is down 50%+).

Rather, I was trying to point out that if you take Buffett's comments out of context, it is all contradictory. So does management matter (Buffett cares a great deal) or does it not (invest in businesses any fool can run). Ideally you would want both but which one would you weight more? Half of what Buffett (or anyone else) says can be contradictory...

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